Brazil guide: The year of the Brazilian stranglehold?

2011 may well prove to be a watershed in Brazil’s investment bank market. For many years, the country has been an attractive growth prospect for the leading international investment banks. Facing sluggish growth in the core developed markets, many Wall Street and European firms have invested heavily in their Brazilian banking teams in the hope of vital fresh revenue streams. But, as the year draws to a close, data from Dealogic suggest that JPMorgan is alone among the international banks to break into the top tier of locals (if we can, for the purposes of this analysis, classify Credit Suisse’s Brazil operations as a hybrid local-international after it bought local investment bank Garantia). The Brazilian banks are becoming dominant in the provision of investment banking services within their own market – and the momentum they are generating throws up a serious challenge to the international banks. The chart shows the top 10 leading investment banks in terms of core investment bank revenues. Locals Itaú BBA, BTG Pactual and Banco Bradesco BBI sandwich the ‘hybrid’ Credit Suisse (second place) and JPMorgan (at fourth). But the locals not only have high ratings, they also have the momentum. Itaú BBA claims the top spot, replacing Credit Suisse, with a 17.5% share. Itaú has, in the past 12 months, won 5.4 percentage points of market share, which is a huge jump. BTG Pactual cements a solid third place with a 13.7% market share (up 1.7 percentage points) and Bradesco BBI increased its market share by 43% to 6.6%.

Throughout mergers and acquisitions, equity capital markets and debt capital markets (all of which have their own chapters in this guide), the growth in the market share of the local players is exceptional. 2011 has in particular been a breakthrough year for Bradesco BBI, which has lagged behind its wholesale banking operation of retail/universal banking competitor Itaú Unibanco. For example, in Brazilian M&A Bradesco BBI jumped from 20th place in 2010 to eighth position year-to-date 2011, with 13.8% market share this year compared to just 2.7% last year. In equity capital markets, Bradesco claims third place with 15% of the market, compared to a ranking of tenth last year on the back of a market share of 5.5%. In domestic debt Bradesco BBI is ranked first in terms of deal volume (compared to fourth in 2010) with a market share of 21.7% (up from 12.9%) and only in international debt did the bank fail to progress, ranked 10th compared to ninth last year. Meanwhile, Itaú demonstrates its leading position by heading the tables for M&A (both in terms of volumes and number of deals) and ECM (both by volume and number). It is now ranked second for local debt in terms of volume (and third in terms of number of deals) and has become fourth largest arranger of international deals in terms of volume (fifth in terms of number of deals). BTG Pactual is ranked second in ECM and fourth in M&A. Big means strong

The strength of Bradesco BBI and Itaú BBA will be hard to shake. These banks, along with the state Banco do Brasil, dominate the retail and corporate banking markets. They are well regulated and capitalized and have plenty of balance sheet and local relationships to deploy. They are in such a strong competitive position that will be hard for many of the international banks that are looking with interest at the size and the growth of the Brazilian investment banks to justify the costs of entry. In fact, UK bank RBS’s recent withdrawal from onshore investment banking with the closure of its São Paulo office, and the recently reported cooling-off of Brazilian bankers’ wage increases (although from a very high base) could be interpreted as signs of a turning point. From here on in, will the domestic banks only expand, further tightening their grip on investment banking services?

New competitors will evolve but these too may be Brazilian in origin. Plural Capital is emerging as a competitor in the BTG Pactual mould – unsurprising perhaps as it is led by two former BTG partners, Rodolfo Riechart and Andre Schwarz, and recently announced the recruitment of fellow BTG colleagues Evandro Pereira and Pedro Guimaraes. Plural’s acquisition of Banco Modal, fell through in November but it is planning to buy another small bank to provide it with a banking licence and it is also understood to be looking to acquire a Brazilian brokerage operation; all of this makes Plural a start-up competitor with the pedigree and the ambition to watch. Meanwhile BR Partners’ acquisition of Banco Porto Seguro is set to make that brazil’s newest bank by the beginning of 2012.

An exception is UBS, which is ready to try again to develop a presence in Brazil following its sale of BTG Pactual, its last foray in the market. UBS expects to obtain a banking licence in the first quarter of 2012 and is moving to new offices. It is optimistic about its aim to build an advisory-led investment banking business, combined with wealth management. It is safe to say UBS’s expansion plans will face a tough competitive environment.

Plural isn’t expected to be a direct competitor to BTG Pactual in the short term. BTG is itself looking to capitalize on its Brazilian market strength to become a truly regional investment bank. In the second half of 2011 the bank announced it was buying Celfin Capital, a Chilean asset manager and investment bank which has itself been expanding in Colombia and Peru in recent years. The tie-up will make BTG Pactual the leading Latin American investment bank, although Itaú BBA and Bradesco report that they are looking at potential regional investment banking targets to propel themselves out of their domestic bases.

Of the international banks in Brazil, JPMorgan is recruiting heavily to create a domestic debt capital markets capability and should it succeed it will remain the best placed of the international banks – alongside Credit Suisse – to take advantage of the expected growth in DCM, ECM and M&A. Deutsche Bank has made strides in DCM and Goldman Sachs has had a good year advising on Brazilian M&A but the locals are looking fearsomely strong across the board.

All banks are also investing heavily in private banking and wealth management services. In late 2010 JPMorgan’s Highbridge Capital Management bought Gávea Investimentos (a hedge fund created by Arminio Fraga, former president of the Central Bank of Brazil), providing onshore asset management and private equity capacity to its private banking clients – within Brazil but also offering Brazilian capability for its offshore clients with interests in the country. Credit Suisse is developing its wealth management division Hedging Griffo and all of the international investment banks at present onshore in Brazil are developing platforms to try to capture a share of this market.

The private banking industry in Brazil is growing quickly, despite the weak global economy. Assets under management (AUM) in the Brazilian private banking system grew by 25%. Again, the locals are capturing the lion’s share of the domestic wealth being created, with Bradesco, Itaú and BTG Pactual growing their market share despite fierce competition from international banks. In private banking, new entrants have been competing with reduced fees and leading private bankers all report that fee income has been growing much more slowly than AUM. Fees have been dragged lower by new entrants, as well as the industry’s reliance on relatively commoditized fixed income products (a by-product of the country’s high real interest rates). Fees have been depressed to such a point that a Euromoney roundtable on private banking in August revealed seemingly real concerns among senior bankers that service levels could be compromised unless the sector finds a way to reverse the recent margin compression.

Small means weak

While the domestic giants grow their private banking, retail, corporate and wholesale and investment banking divisions, the future looks far less rosy for Brazil’s smaller banks. Banking privatization and consolidation in the 1980s and 1990s created a banking system that had a huge disconnect between the very large and the proliferation of smaller banks. The business model for these smaller banks has been hit in 2011 by increased capital adequacy regulations and greater competition (especially from the new consumer finance operations of leading retailers) which is putting pressure on margins. The central bank is also withdrawing the support that the government-run bank deposit insurance fund FGC gave to the industry in the 2008 crisis. During the crisis the FGC provided deposit guarantees but it is now withdrawing this support, effectively increasing the risk of banking with the smaller entities and increasing their financing costs. Brazil’s central bank is focused on managing this process with government-sponsored consolidation but both Itaú and Bradesco have ruled out participating with acquisitions of its smaller rivals. For these banks domestic retail growth is organic: the future of acquisitive growth will be focused on growing their respective international banking divisions within the region and maybe further.

Indeed, so quick is the growth of the Brazilian investment banks and so ambitious the international expansion plans, the international banks currently struggling to generate market share in the country may have well soon have to worry about defending their market share against the Brazilians in other countries throughout the region.